Initial Thoughts on Unilife’s New Debt Financing

Since I started looking at Unilife (UNIS), I’ve been extremely concerned with the company’s liquidity and solvency situation. They’ve been burning through cash like it’s going out of style and operating expenses are already very high and have kept growing at a fast pace. Operating losses every year meant the company already has significant negative debt service coverage ratios (i.e. they burn cash to pay debt service rather than using operating income to pay interest/principal). At the end of the last quarter (Dec 31), they were already highly levered with a Debt/(book) Equity ratio of ~0.74, placing UNIS in an elite group of companies — 0.74% of the 6,795 stocks in the Finviz.com database — with such high leverage and negative margins.
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Unilife, Or: When A “Growth” Pure-Play Isn’t A Smart Play

I come from the school of fundamental value analysis/investing. So when a client asked me to look into Unilife Corp (UNIS) a few weeks ago, naturally, my first reaction was to look at their SEC filings and financial statements. It became immediately clear (as it should to anyone who’s spent more than 60 seconds looking) that this was not a company on which one could perform a discounted cash flow (DCF) valuation or any other traditional fundamental valuation, since their financials are an absolute and utter disaster of the highest order. DCF won’t work – it’d just be adding an enormous degree of false precision/certainty to an extremely uncertain and unpredictable set of financials – and comps are only useful insofar as they not only exist, but have similar activities, capital structures, etc. Option valuation is just another exercise in futility, especially considering the firm’s financial and operating history is all over the place, making any assumptions/inputs useless.

So how then are we supposed to value this company? Continue reading

The Limit of Fundamental Analysis: You

The other day, my friend Eddy Elfenbein wrote a post entitled “The Limits of Fundamental Analysis,” which made some good points (as he most always does), but in so doing, made far too broad and thus inaccurate a conclusion. The premise is (and I welcome Eddy to correct me if I’m off-base) that in some circumstances, fundamental analysis is inappropriate, such as when dealing with transformational businesses like Amazon was (is), cyclical firms, leveraged firms, firms with varying earnings quality, etc. The thing is, we can – and do (try to) – adjust for all of these things – and more – when performing a proper fundamental analysis! I’m going to attempt to show how, by making relatively small changes to a few key assumptions (sometimes even just one number will do!) in a simple DCF framework, we can grossly change not just how much we think a stock is worth, but why it’s worth that price, as well.

Fundamental analysis, by definition, involves examining the industry in which a firm competes, the regulatory/legal environment, the market for a firm’s goods/services, the goods/services themselves, the firm’s financial condition/performance, strategy, capital structure, reliability of financial statements/accounting controls, and several other factors, not only currently, but in the past and, more importantly, the future as well. Fundamental analysis isn’t just looking at a few ratios on Yahoo Finance or Finviz or whatever and concluding a company is a good (bad) investment based on valuation, liquidity, solvency, and/or other metrics. That can be the starting point for narrowing down firms which are more (less) likely to be worth investigating further, given a finite amount of time to allocate to identifying and researching ideas which we hope will help us invest wisely.

A quick tangent: If you’re not in the markets to invest, you are in the markets to gamble. This is not up for debate, it just is; if you find or fancy yourself a gambler, save the trouble and head to your closest casino where they’ll be more than happy to separate you from your presumably hard-earned money quite expeditiously (you may even get some “free” food and drink out of it). If you’re not sure whether you’re trying to invest or gamble, just put your money under your bed until you figure it out, you’ll be doing yourself a favor. If you’re interested in making good investment decisions, this is where the fun starts…

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Seeking Part-time Interns for Fall/Winter

Since I started Stone Street Advisors LLC’s internship program, I’ve largely been impressed with the talent we’ve attracted, and proud of the positions our interns have landed after working with us. Alas, as each moves on to bigger things, it comes time again to recruit two more part-time interns for the fall semester, hopefully working through winter and perhaps into spring, as well.

Unlike the vast majority of internships, everything from our recruiting process to training to responsibilities have been carefully designed & implemented to prepare you for ultra-competitive positions at the best firms in the world. Below, I’ll describe these things, and upon consideration, you are welcome to apply.
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Quick Observations on JOSB, GPS

Wednesday night (6/5/2013) I needed to track down a specific pair of jeans in my very specific size. My build notwithstanding, the closest place I could find them was in Denville, NJ Banana Republic at the Shoppes at Union Hill, a semi-kind of upscale-ish, well-polished shopping center. I have a few quick observations/comments/questions based on this one experience, in no particular order:
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FT Alphaville CFA Meme Contest Silver Medal for Dutch Book!

The Financial Times’ great Alphaville division held a semi-quasi-formal-ish CFA exam meme contest, in which our man Dutch Book participated. Result: Silver medal (although I think he should have easily won the gold with his submission!). Stone Street Advisors: Winners at the research and meme game. (non-official motto).

Here’s Dutch’s second-place submission:

#SoMuchWin

Congratulations to Dutch Book & best of luck on the exam, which he’ll no doubt ace.

–JT

When Life Kicks You In The Butt…

My friend, my mentor, and one of our SSA teammates is in a bit of a squeeze. Per his last semi public update:

“I have a stage 2heartblock which causes me to blackout when I get dehydrated. happened Saturday morning on my way to play golf. I was taken to ER and given to IV drips. Was ok yesterday, but was in bad shape this am. So I’m currently at NYU Hospital being monitored.”

If that doesn’t scare the ever loving shit out of you to he point of action, you are a sick bastard.

While GTJ has some insurance $, anyone who knows how these things work knows damn well the $1,000′s accumulate extremely fast. I’m not asking for a Billion (we’d accept most of it though) but I want everyone who follows him on twitter, and reads his posts here and elsewhere to pray or do whatever you believe in that he’s healthy asap. We, no, I am not asking for any donations, but I will consider an offer if that is the way you want to play it.

My Friend, my Mentor, and again, My Friend is in an unenviable condition. Please do whatever you can to help.

Information @ StoneStreetAdvisors dot com.

I will match any donations as well as I can; any additional monies will go into a newly established charity which will be used for similar situations; zero will come to me or my firm.

Please wish him well, if you don’t have the money.

Jordan S. Terry
Founder & Managing Director
Stone Street Advisors LLC

Fear Not Every Penny Stock

A lot of people, finance professionals/academics and amateurs alike, will tell you that investing in penny stocks is inherently and necessarily risky, primarily by virtue of generally having small market capitalizations (e.g. below $100 million) and low stock price (e.g. below $5 in the U.S.) As I mention in all of my reports and articles on penny stocks, the lower the price, smaller the market cap, and lower the trading volume, the more susceptible the stock is to manipulation by unscrupulous types, typically using so-called “pump & dump” or “short & distort” schemes. Luckily, these risks can be minimized by using stop/limit (instead of market) orders along with proper position sizing relative to average volume to limit your downside risk and/or lock in profits. This, however, is not a column about trading (although that’s part of the process), it’s about fundamentals of business and investing, and that’s where I want to focus today.

So, now that we know how to (try to) minimize our risks on the trading side, how do we manage the risks associated with the underlying business? First, it depends on how one defines risk, or more accurately, what risks one is able to identify. Just because a penny stock is a small/micro-cap and/or development/transformation stage company doesn’t mean you can’t apply some of the same analytical techniques we use for larger companies to identify risks and determine if a given stock is worth your investment dollars. Interestingly, even the SEC has this to say about the risks of micro-cap stocks, emphasis mine:

“While all investments involve risk, microcap stocks are among the most risky. Many microcap companies tend to be new and have no proven track record. Some of these companies have no assets or operations. Others have products and services that are still in development or have yet to be tested in the market.”

This is a bit of an overgeneralization lacking nuance, but many penny stocks are fundamentally quite similar to the private early-stage companies that venture capitalists and angels invest in; The SEC’s comments could easily apply to both early-stage public and/or private endeavors. Harvard Business School senior lecturer Shikhar Ghosh has some very interesting stats and perspective on start-up/early-stage business failures. Barring outright fraud (more on this later), the reasons and frequency cited for business failure are probably not too much different for early-stage public firms than for private ones (not sure of data on this, but that’s the topic for another article).

So, how do we determine if it’s worth investing in a given penny stock? Generally, I prefer a primarily bottom-up approach with a healthy amount of deference to the top-down, regardless of market cap, and I think such a combination works especially well for penny stocks. Recently, a client hired us to research a volatile micro-cap penny stock, Nuvilex (NVLX) . I’m not going to get into too much detail about the specific project, but I want to use the company/research approach to illustrate how disciplined investors can separate the wheat from the chaff when it comes to penny stocks.

At first, I was skeptical of Nuvilex (not a surprise occurrence as I’m a skeptic first all the time); micro-cap stock, very volatile, very low price, barely any revenue, generally terrible financial statements, and a strange operating history spanning a decade and a half. The more research I did, though, I realized – again, barring outright fraud – the company’s technology has enormous potential. A simple Porter’s Five Forces analysis is always a good way to start, on any stock/company, again any market capitalization.

On a 1-10 scale I’d give Nuvilex a 7.5-8.5 on the five forces based on the public information I’ve reviewed. Regardless, this company, on a stand-alone basis, could change the way cancer, diabetes, and other horrible diseases are treated if not cured. Additionally, it’s a play on the inevitable paradigm shift in medical technologies coming from cell therapy and stem cell advancements. Bottom-up meets top-down; easy, right? Wrong!

Just because from 30,000 feet everything seems promising, we have to get a little closer to ground level, lest we miss something obvious like shady management, impossible financials, etc. I actually found it somewhat reassuring to see Nuvilex’s financial statements seem accurate compared to the story woven by management; many pump & dump, “fraudcap” (colloquialism for fraudulent or otherwise questionable micro-cap stocks) companies file SEC reports that make absolutely no sense given the market/industry and the idiosyncratic attributes of the company in question. Nuvilex’s tech has intellectual property protection, plenty of publications, accomplished leadership, and technology that could help extend if not save lives. When I was looking for competitors, I found one that explicitly disclaimed responsibility for all IP violations and said any issues were their customers’ problem. Amazing, no? Moving on…

The key takeaways here are 1. Don’t judge a book by its cover (or a stock by its price/market cap, 2. Most people don’t have a clue about investing (even some professionals), so beware word of mouth “advice,” 3. Always do your diligence and be on the lookout for shady #’s and characters; if it seems too good to be true, it probably is.

As always,

CAVEAT EMPTOR

Nuvilex: A Penny Stock That Could be a Disease-Fighting Game Changer

Nuvilex (NVLX) is a company that I’d never heard of until about about a week ago when a client asked me to take a look. At first glance, my reaction was something along the lines of “why should I be bothered with a $0.05/share microcap transformational/developmental stage biotechy company with downright scary financials and a strange history?” After doing a ton of reading and research, I’m starting to realize why I – and you – should care about this company, regardless of it being a volatile microcap OTC penny stock.

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Howard Marks – Investing in Uncertain Times

While I’m sure I’m not nearly the 1st person to post this from the Oxford Private Equity Institute Conference on March 5th, I thought it an interesting read (especially if you’ve read him previously).

Perhaps the presentation is best summarized by the quote on page 2, to which the entire page is dedicated.  I find this particularly disturbing:

You can read the full post here:129134638-Howard-Marks-Investing-in-Uncertain-Times